Intangibles Assests

For accounting purposes, the classification intangible assets refers to nonphysical assets such as patents, copyrights, franchises, leaseholds, goodwill, etc. The basic value of these assets is derived from their potential earning power for the business. Whether this earning potential is ever realized is, of course, another matter.

Valuation of Intangible Assets

As with other assets, the valuation basis for this category is cost. The value of the intangible is written off over its useful life and charged against the revenue it produces.

When an intangible is acquired by purchase, its cost includes all associated acquisition expenses (i.e., 'technical drawings, legal and consulting fees, license applications, etc.), When such assets are acquired by exchange (i.e., for nonmonetary assets), the fair market value of the asset exchanged or that of the intangible, whichever provides clearer evidence, is used to assign a cost to the asset acquired.

With respect to internally developed intangibles, the difficulty in distinguishing revenue expenditures from capital expenditures has resulted in several acceptable treatments of research and development costs:

(1) Where research and experimental costs can be associated with a specific project, they are summarized and included with all other development expenses in the reported cost of the intangible.

(2) Research and development costs which mayor may not benefit revenue in future periods may be expensed as incurred, according to function (i.e., sales, manufacturing, etc.), Tax laws encourage this approach as a stimulus to economic growth.

(3) An alternative to (2) above is the capitalization of research and development costs and the subsequent amortization of such amounts over the useful lives of those projects having profitable results.

Amortization of Intangibles

The process of writing off the cost of intangibles is called amortization. However, not all intangibles are subject to amortization; thus, two distinct categories of intangible assets are generally recognized.

(1) Limited Existence. Some intangibles have a limited term of existence as a result of governmental laws, regulation or contractual arrangement. This category includes patents, copyrights, leases, fixed-term franchises, and goodwill for which there is evidence of a limited life.

These assets are amortized over their useful service lives (i.e., in the same manner as depreciable assets). The straight-line method is generally used, although an accelerated method may be substituted if there is evidence that a greater part of the value will be lost in the earlier years than in the later ones.

(2) Unlimited Existence. This category includes such intangibles as goodwill, trade names, subscription lists and perpetual franchises which possess no indication or evidence of limited existence. Although no amortization would seem the logical treatment for these assets, APB Opinion No. 17 states that it is an acceptable accounting principle to write them off over some time period for balance sheet purposes, and that the time period selected should not be more than forty years. It specifies, however, that "the cost of each type of intangible asset should be amortized on the basis of the estimated life of that specific asset and should not be written off in the period of acquisition."

Identifiable Intangible Assets

This section deals with the various intangibles which can be identified as distinct and separate property rights. These assets can be contrasted to others, e.g., goodwill, which by virtue of being specifically unidentifiable, require special accounting considerations.

(1) Patents. Granted by the Federal government, patents give the owner an exclusive right to manufacture and sell, or otherwise control, a particular invention or discovery for a period of 17 years. At such time, the invention or discovery enters the public domain, and is available for use by others without payment of any royalty or license fees. Patents are not renewable; however, new patents may be obtained on the basis of improvements in the original invention or discovery.

Patents may be amortized over their legal lives; however, since a patent's economie usefulness is generally less than 17 years, shorter amortization periods are the usual case.

(2) Copyrights. Unlike patents, copyrights give the owner an exclusive right to a literary or artistic creation for a period of 28 years which is renewable for an additional 28-year period. Rights to copyrighted material may be leased, assigned or sold.

In theory, copyright costs should be amortized against total revenues resulting from the copyrighted work. However, since such revenues are difficult to estimate, the amortization period is generally short and in some cases, copyright costs may be written off against the first revenues received.

(3) Trademarks and Trade Na17U!S. These distinctive means of identification, together with symbols, labels and design, represent important property rights to the owner inasmuch as they are forms of advertising having great impact on a product's reputation and consumer confidence in it. They can be bought and sold in their own right.

While developing this particular asset requires great monetary investment, a value is usually not assigned unless there has been a purchase acquisition. Even in such cases, the value is typically written off  over a period shorter than the 4O-year limit, or the asset may be carried at a valuation of $1 just to call attention to it in the balance sheet.

(4) Organization Costs. This category encompasses expenses incurred in the formation of a business (i.e., creative, legal, accounting and incorporation fees, etc.). Since it is assumed that these will be recovered through profitable operations, they are considered an asset rather than a reduction in capital. Theoretically, organization costs are an asset as long as the business continues in existence; however, practical considerations dictate that they be amortized over a relatively short life (typically, five years for income tax purposes) in the balance sheet.

Organization costs do not include operating losses in initial years of operation, initial advertising costs, bond discount and issuance costs, etc. Such expenses should be deducted from revenues, classified as deferred charges or deducted from security face value and amortized over the life of the obligation.

(5) Leaseholds and Leasehold Improvements. A leasehold is a right granted to a lessee (business or individual) for the use of real property owned by a lesser (landlord). Leaseholds cover a specified time period and require the payment of rent. Leasehold improvements are betterments of rented property (i.e., resurfaced lots, building modification, new structures, etc.) effected by the lessee. When the estimated useful life of the improvement exceeds the life of the leasehold, it is amortized over the life of the lease as ownership reverts to the lesser when the lease expires. Otherwise, the useful life of the improvement is used as the amortization basis.

(6) Deferred Charges. This catch-all category covers significant expenditures expected to benefit future periods, although they do not directly result in assets, intangible or otherwise. Research and development costs, plant rearrangement costs and mineral exploration costs are examples of such charges; they are amortized over their useful lives. Because the term deferred charges does not clearly identify the nature of the asset(s), modern accounting theory discourages its use in favor of more specific account titles.